Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
What is it?
A qualified defined benefit plan that provides for annual
employer contributions at a specified rate to
hypothetical individual accounts that are set up for each
plan participant
Employer guarantees
– contribution level
– minimum rate of return on each account
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
When is it indicated?
• have relatively young employees with substantial
years to accumulate earnings
• employees concerned with security of retirement
income
• workforce large and most are middle-income
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
When is it indicated?
• employer able to spread administrative costs over
relatively large group of employees
• employer wants to convert existing defined benefit
plan to plan that
– provides more attractive benefit for younger employees
– may lower costs for older employees
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Advantages
• Tax deferred savings
• some older employees may be able to use 10 year
averaging
• employee does NOT have investment risk
• within limits, plan guaranteed by PBGC
• plan benefits easily communicated and understood
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Disadvantages
• retirement benefit may be inadequate for older plan
entrants
• complex to administer
• employer bears investment risk, increasing employer
costs
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Design Features of These Plans
• hypothetical individual account for each participant
• credits by employer at least annually with
– “pay credit”
– “interest credit”
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Design Features of These Plans
• employer’s annual cost for plan determined on
actuarial basis
• employer must make up difference if actual plan
earnings fall short of total interest credits
• plan participants do not have investment choice
• loans can be made available but due to
administrative problems are seldom offered
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Design Features of These Plans
Modification of Existing Defined Benefit
Formula
– If employer dissatisfied with defined benefit plan,
less costly to convert to cash balance pension
than to convert to defined contribution plan
– conversion can reduce accrual rate for
employee’s benefit
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Tax Implications
• employer plan contributions tax deductible when
made
• Section 415(b) defined benefit plan limits apply to
cash balance plans
• employee defers tax on employer contributions
• rules for qualified plan distributions must be followed
• some older employees may qualify for 10 year
averaging
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Tax Implications
• plan subject to Sec 412 minimum funding rules
• plan subject to PBGC mandatory coverage
• some employers can receive business tax credit of
up to $500 for “qualified plan startup costs”
• plan may permit “deemed” IRA
• plan subject to ERISA reporting and disclosure rules
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Alternatives
money purchase and profit sharing
– build up qualified retirement accounts for employees
– do not guarantee a minimum investment return
defined benefit plans
– guarantee employee benefits, but
– complex to design and administer
individual retirement savings
– only IRA allows tax deferral
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
True or False?
1. A cash balance plan offers an adequate retirement
for older entrants.
2. Cash balance plans have cheaper administrative
costs than defined contribution plans
3. An advantage of a cash balance plan is that there is
very little administrative cost.
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
True or False?
4.
A pay credit allocates plan investments according
to an employee’s pay.
5.
Employees bear investment risk with a cash
balance plan.
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Discussion Question
What factors would encourage an employer with a
defined benefit plan to convert to a cash balance plan?
After such a conversion, who are or would be the
‘winners’ among the employees and who are or would
be the ‘losers’?
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Cash Balance Pension Plan
Chapter 15
Employee Benefit & Retirement Planning
Design Features of These Plans
“pay credit”
uses compensation-based formula
may be integrated with Social Security
“interest credit”
amount of employer-guaranteed investment earnings credited
annually to each employee’s account
must follow plan formula, cannot be discretionary
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